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Political risks on the rise in advanced economies

22 November 2018

The recent financial volatility in Argentina and Turkey has focused attention on emerging markets, but appropriate insurance cover could also mitigate the political risks in many advanced economies. The effects of the 2008 financial crisis continue to erode the political centre-ground and fuel dissatisfaction with economic liberalism in developed states. In the United Kingdom (UK), the possibility of an early general election increases the nationalisation risks facing utility companies, while Italy has defied the European Union (EU)’s calls for it to revise its spending plans. Political uncertainty and the threat of auto tariffs weigh on the outlook for Germany, and the risk of politically motivated violence is likely to rise in the United States (US).

UK: UTILITIES FACE NATIONALISATION RISKS

It is highly uncertain if the draft Brexit agreement agreed between Theresa May’s Conservative Party government and the EU will be approved by UK Parliament. If the deal fails to win a parliamentary majority, a general election – which is not scheduled to take place until 2022 – could be held in 2019. The Labour Party is polling closely behind the Conservatives and plans to nationalise the UK’s water and energy industries, railways and Royal Mail.

Labour has said that investors would be compensated by a sum determined by Parliament, but it is unclear if this would be below market value. Investors from countries that have bilateral investment treaties with the UK may benefit from stronger legal protection against the payment of inadequate compensation, but many stakeholders would have to rely on a less clear-cut legal challenge through the Human Rights Act.

ITALY: BUDGET DISPUTE SET TO ESCALATE

Italy’s anti-establishment government has refused to heed the European Commission’s calls to revise its spending plans, raising the possibility that financial penalties are imposed against Rome. After forming a coalition in June 2018, the right-wing League and Eurosceptic Five Star Movement have sought to reverse austerity measures and kick-start Italy’s sluggish economy. The coalition is targeting a looser budget deficit target of 2.4% of GDP in 2019 as it proposes to lower certain tax rates, provide wage guarantees and reduce the retirement age.

However, Brussels rejected the Italian government’s draft budget in October 2018, arguing that a rise in public spending would place additional strain on the public debt-to-GDP ratio, which already exceeds 130%. While an increase in spending would support higher economic growth, it is expected to be offset by a rise in borrowing costs. Over 36% of Italy’s debt stock is due to mature over the next three years, and the majority of it will need to be rolled over. Even without the increase in spending, Italy’s financing costs are already set to rise as the European Central Bank ends its quantitative easing programme.

Italy has refused to make any major alterations to its proposals and, as a result, the European Commission could impose budget violation penalties against Rome, starting at 0.2% of GDP. If the Italian government bows to pressure from the EU and reduces its proposed spending then it could provoke civil unrest, while continued commitment to the budget would elevate sovereign credit risks.

RISKS ON THE HORIZON IN GERMANY AND THE US

Political risks are also emerging in a number of other advanced economies. Germany’s ruling parties fared poorly in recent state elections, leading Chancellor Angela Merkel to announce that she would not seek re-election at the end of her term in 2021. The political centre has weakened in recent years and early elections may be called. In addition, there is a growing risk that the US will impose a 25% tariff on auto imports from the EU, which would have a particularly significant impact on the German car industry.

In the US, the Democrats retook control of the House of Representatives in the mid-term elections held in November 2018. The Democrats are likely to use their control of the House to launch investigations against President Donald Trump, which could increase the risk of active shooter attacks by disgruntled right-wing extremists. Large protests will remain likely in major cities in the one-year outlook, while the risk of firearms attacks by both left- and right-wing extremists is expected to increase in the lead-up to the 2020 presidential elections.

Jardine Lloyd Thompson Group plc

Jardine Lloyd Thompson Group plc, incorporated and registered in England and Wales. Registered Office at The St Botolph Building, 138 Houndsditch, London, EC3A 7AW. Registered number 1679424. Jardine Lloyd Thompson Group plc is a holding company, some of whose subsidiaries are authorised and regulated by the Financial Conduct Authority.